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Inflation, interest and exchange rates in the transition1

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  • Domenico Mario Nuti

Abstract

Central and Eastern European economies have made extraordinary progress in their trade and exchange regimes. Surprisingly, instant convertibility was established for a great variety of exchange rate regimes. In spite of diversity, all these countries have followed a common pattern: severe initial undervaluation ‐ the cost of speed and unrestricted trade ‐ followed by rapid real revaluation and incipient protectionism. Since 1994 in many cases an embarrass de richesse has appeared: high capital inflows which are either inflationary or costly to sterilize. A major cause of these flows ‐ or at any rate of the high cost of sterilization ‐ is the presence of significant interest rate differentials higher than required to cover the risk of devaluation. These are the necessary consequence of a policy of positive real interest rates and of real revaluation from excessively undervalued exchange rates. Lower interest rates are recommended, both to stem financial capital inflows and to reduce the cost of their sterilization.

Suggested Citation

  • Domenico Mario Nuti, 1996. "Inflation, interest and exchange rates in the transition1," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 4(1), pages 137-158, May.
  • Handle: RePEc:bla:etrans:v:4:y:1996:i:1:p:137-158
    DOI: 10.1111/j.1468-0351.1996.tb00166.x
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    References listed on IDEAS

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    1. Michael Bruno, 1990. "High Inflation and the Nominal Anchors of an Open Economy," NBER Working Papers 3518, National Bureau of Economic Research, Inc.
    2. Halpern, László & Wyplosz, Charles, 1995. "Equilibrium Real Exchange Rates in Transition," CEPR Discussion Papers 1145, C.E.P.R. Discussion Papers.
    3. Portes, Richard, 1994. "Transformation Traps," Economic Journal, Royal Economic Society, vol. 104(426), pages 1178-1189, September.
    4. Mr. Carlos A. Végh Gramont & Ms. Ratna Sahay & Mr. Guillermo Calvo, 1995. "Capital Flows in Central and Eastern Europe: Evidence and Policy Options," IMF Working Papers 1995/057, International Monetary Fund.
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    Cited by:

    1. Payne, James E., 2002. "Inflationary dynamics of a transition economy: the Croatian experience," Journal of Policy Modeling, Elsevier, vol. 24(3), pages 219-230, June.
    2. Anders Aslund, 2012. "Why a Breakup of the Euro Area Must Be Avoided: Lessons from Previous Breakups," Policy Briefs PB12-20, Peterson Institute for International Economics.
    3. Estrin, Saul & Uvalic, Milica, 2021. "The life and works of Domenico Mario Nuti, 1937–2020: an appreciation," LSE Research Online Documents on Economics 111911, London School of Economics and Political Science, LSE Library.
    4. Lucjan T. Orlowski, 1996. "The Path of Exchange Rates in the Polish Economic Transformation," CASE Network Studies and Analyses 0090, CASE-Center for Social and Economic Research.

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